United States: Hammers Disguised as Amnesties: States Take a Wrong Turn

In their zeal for tax revenue, state legislatures have enacted tax amnesty programs with increasing frequency. As a result of the startling successes of many of the programs, which had been touted as "One Chance for a Second Chance,"¹ "first and only,"² or a "once-in-a-lifetime opportunity,"³ additional opportunities often followed at their heels, dubbed by one state official as "a second once-in-a-lifetime opportunity."⁴ The Director of the Missouri Department of Revenue, in response to the enactment of back-to-back amnesty programs in 2002 and 2003, stated that she hoped that the Missouri Legislature did not "go for a trifecta."⁵

Since the first state tax amnesty program was enacted by Arizona in 1982, through January 2005, 40 states plus the District of Columbia and certain localities have adopted at least one amnesty program.⁶ Most of the states have enacted amnesty programs multiple times, including several which have enacted three or more general amnesties, which are available with respect to all or most of the significant taxes imposed by the taxing jurisdiction, within the last 23 years, i.e., Connecticut, Massachusetts, Missouri, New Jersey, and New York. Louisiana has the distinction of having had four general amnesties in the last 20 years.⁷

While some states have enacted general amnesties, others have restricted amnesties to only certain taxes or situations. Virtually all types of taxes have been covered – income, property, sales, withholding – to name just a few. Recently, several programs have targeted taxpayers that have participated in "abusive" tax shelters.⁸ "Abusive," however, is in the eye of the beholder. States apparently have forgotten the time-honored precedent that avoidance transactions are acceptable and only transactions that evade taxation are prohibited.

The widespread use of amnesty programs by the states and their frequency are not surprising given their purported financial successes.⁹ Although a few programs did not meet their revenue targets,¹⁰ most brought in revenues far in excess of estimates. For example, South Carolina’s 2002 tax amnesty program collected 12 times the amount of revenue it had expected;¹¹ New Jersey’s broad-based 1996 program generated five times its estimate;¹² and California’s 2004 amnesty program for tax shelter participants yielded a startling $1.4 billion, which was dwarfed by the almost $3 billion brought in by the Franchise Tax Board during its most recent foray into the amnesty realm, albeit most of the revenue was not paid as part of the amnesty program, but to circumvent the amnesty program.¹³

Amnesty programs’ target audiences vary. Although the programs often target non-filers with the goal of placing these taxpayers on the states’ tax rolls, they have been enacted to target collection of accounts receivable (e.g., collect on outstanding warrants) or to encourage taxpayers with "tax shelters" to come clean.

The states’ munificence has varied from generous – full waivers of interest and civil penalties, a promise to forgo any potential criminal action or penalties, and even limited look-back periods – to onerous – threatening the imposition of newly enacted penalties on those who chose not to take advantage of the "voluntary" program. With alarming frequency, states have opted for the latter programs. Many of the elements of these programs are harsh and ripe for constitutional challenge.

"Amnesty" is defined (from the Greek amnestia, oblivion) as "an act of justice by which the supreme power in a state restores those who may have been guilty of any offence against it to the position of innocent persons. It includes more than pardon, inasmuch as it obliterates all legal remembrance of the offence."¹⁴ Amnesty does not release the grantee from guilt but from the penalty that, but for the grant of amnesty, would be imposed by law for such guilt.¹⁵

In ancient Egypt, pharaohs were known to grant pardons for unpaid taxes during periods of hardship, in a practice known as "philanthropa" (from which the word "philanthropy" is derived).¹⁶ During the reign of Ptolemy V, around 200 B.C., a "Proclamation of Peace" was inscribed which included tax amnesty provisions. Tax debts were forgiven, and tax debtors were freed from prison. A copy of this Proclamation of Peace was found by one of Napoleon’s officers inscribed on black basalt – the famous Rosetta Stone.¹⁷ As a result of oppressive taxation, it was believed that huge amounts of unpaid taxes had accumulated, resulting in massive confiscation of property and incarceration of many able-bodied tax debtors. Amnesty allowed the confiscated land to be returned to productive use by the formerly imprisoned tax scofflaws. As one scholar noted, "the grants of tax immunity set down in the Rosetta Stone paint a pitiful picture of Egypt and indicate that her rulers were driven to take desperate measures to end the social and economic chaos their excessive tax systems had created."¹⁸ Apparently, the tax amnesty was deemed successful; three additional tax amnesties were ordered during the following century "as a regular medicine to check civil disorder."¹⁹

Tax amnesties have been used in many countries in both the developed and the developing world. In addition to countries in the Organisation for Economic Co-operation and Development (OECD) and most of the states in the United States, amnesties have been employed in Austria, Australia, Belgium, Finland, France, Greece, Ireland, Italy, Portugal, and Switzerland. Developing countries, where they have been employed often repeatedly, include Argentina, Bolivia, Chile, Colombia, Ecuador, India, Pakistan, Panama, Peru, Mexico, and the Philippines.²⁰ It has been argued that weak governments enact tax amnesties.²¹

Although the Internal Revenue Service ("IRS") had an administrative voluntary disclosure policy which offered taxpayers amnesty from criminal penalties (but not interest or civil penalties), that policy was officially discontinued in 1952, and the Federal government has never instituted a formal general amnesty program, although enactment of an amnesty program has been considered many times.²² Notably, preceding the passage of the Federal Tax Reform Act of 1986, 13 different amnesty bills had been proposed.²³

The wisdom of providing tax amnesties has been the subject of much debate. Some are of the opinion that tax amnesties, by their very nature, are the antithesis of the fundamental notion that punishment should follow crime.²⁴ As one commentator summed up: "A tax amnesty, by excusing civil and criminal penalties for avoidance of tax obligations, effectively severs the relationship between crime and punishment and compromises the fairness of the tax system."²⁵

As a rule, tax officials do not favor tax amnesties since they benefit the non-compliant rather than the honest taxpayer. One small study confirmed the perception of many tax officials, finding that most individuals did not believe the government’s statements that the program was a one-shot deal, and thought it was unfair to those who filed and paid their taxes timely.²⁶ Another study concluded: "Amnesty expectations reduce the positive effects of amnesty. When the state does not keep its promise, tax compliance decreases. Such a result has a strong policy implication. If a state had the intention to increase the long-term effects of a tax amnesty, its commitment should be reliable, and only one amnesty should be conducted per generation."²⁷ Legislators, however, focus upon the short-term infusion of cash and are usually not concerned with the potential long-term detrimental effects of an amnesty program.

In 1984, the United States Treasury Department rejected the enactment of any type of amnesty program, stating: "To include tax, civil penalties, and interest in an amnesty would further undermine taxpayer morale by sending a clear signal to the American public concerning non-compliance and tax fraud: ‘Don’t bother to pay now. We may forget you owe anything. Even if you have to pay tax, we won’t charge interest.’"²⁸ The Treasury Department’s 1984 report also noted that amnesties "reinforce the growing impression that the tax system is unfair and encourage taxpayer noncompliance."²⁹

In 1990, an IRS commissioner concluded that a Federal tax amnesty would be "ill-advised and counter-productive."³⁰ From an economic perspective, the Joint Committee on Taxation’s 1998 report on tax amnesty noted that economists had observed that "the granting of amnesty will forever change taxpayers’ perceptions of the ‘rules of the game’ between the taxing authority and the taxpayer. Once an amnesty is granted, taxpayers may perceive that the likelihood of future amnesties has increased, and thus an incentive may be created to evade current taxes in anticipation of the future amnesty."³¹

Amnesties also upset tax systems’ horizontal equity, i.e., treating those in similar economic circumstances equally, by treating those similarly situated differently. Further, with respect to amnesties that focus on collection and not on non-filers, the revenue is arguably merely accelerated; no new revenue source is tapped. One commentator called the states’ amnesty successes "illusory," citing the results of California’s 1985 amnesty program, in which the Franchise Tax Board had concluded that it would have collected 78% of the revenues even without the amnesty program, and an Illinois program would have collected 75% irrespective of its 1984 program.³²

To assuage their unhappiness with such programs, tax departments urge legislatures to enact punitive provisions, which are appended to the amnesty programs. Tax officials lamented at one conference that the tax department did not have "a new stick," having enacted a 20% collection fee as part of the state’s last amnesty program.³³ Use of the "stick," that is, implementation of excessive enforcement provisions, however, can "undermine compliance if such enforcement leads to an unnecessarily adversarial relationship between the taxpayer and government, leading taxpayers to ‘get back’ at the government by evading taxes."³⁴ Significantly, moreover, there is no consensus that an amnesty that has increased post-amnesty enforcement provisions reaps better results.³⁵

While increased enforcement after an amnesty program might aid in the program’s ultimate success (although there is evidence to the contrary), threatening to impose onerous penalties against taxpayers who have good- faith bases to challenge impositions is contrary to the fundamental goal of amnesty, is oppressive and unfair, and more importantly is violative of due process rights.

The first of the states to change the fundamental nature of amnesty programs was Illinois. Its Tax Delinquency Amnesty Act of 2003 covered tax periods ending after June 30, 1983 and prior to July 1, 2002. It ran from October 1, 2003 through November 17, 2003, and covered all taxes administered by the Department of Revenue with the exception of the Motor Fuel Tax.³⁶ While certain of the provisions were generous – all penalties and interest would be abated – the punitive nature of the amnesty program was just as "generous" – taxpayers that failed to take advantage of the program would have interest and penalties assessed at 200%.³⁷ As the chief of staff of the Illinois Department of Revenue was quoted as saying with respect to the imposition of the 200% penalty and doubling of interest provisions: "It’s a big stick. We wanted a big stick."³⁸

Taxpayers paying under amnesty were required to relinquish their refund rights. A limited exception was provided for changes to taxpayers’ income due to final determinations by the IRS or Federal courts.³⁹ The program introduces a prophetic element into tax administration, providing that "[f]ailure to pay all taxes due to the State for a taxable period shall invalidate any amnesty granted under this Act."⁴⁰ The regulations state that "a taxpayer must pay the entire liability for a tax type and tax period, irrespective of whether that liability is known to the Department or the taxpayer, or whether the Department has assessed it."⁴¹ While using a big stick against tax scofflaws may arguably have some merit (but not necessarily in the context of an amnesty program), it is egregious to use a big stick against unwitting and unknowing taxpayers.

Although the onerous penalty and interest provisions are troubling in and of themselves, particularly the assertion of the double interest and penalties against the unsuspecting, it is the "Catch-22" situation, i.e., either opt for amnesty and relinquish the right to pursue legitimate challenges to assessments or pass on amnesty and be subjected to the amnesty penalties if the challenge is unsuccessful, that is offensive to and violative of fundamental due process rights.

One example in the Department of Revenue’s regulations provides that the amnesty penalties would apply to a taxpayer with questionable nexus "if a court were to determine" that nexus exists.⁴² As state and local tax professionals are aware, nexus is a highly contested issue throughout the country with varying results. Fundamental notions of fairness require that taxpayers not be penalized for having exercised their due process rights.

While taxpayers that had civil cases pending in state courts were not eligible for amnesty, taxpayers who were contesting liabilities asserted before the Department of Revenue’s Office of Administrative Hearings were deemed eligible for the program.⁴³ If these latter taxpayers wanted to avoid the potential imposition of amnesty penalties, they had to either "stipulate to judgment in favor of the Department"⁴⁴ or dismiss their administrative protests, pay under the Protest Monies Act, and commence civil litigation.

Taxpayers that had received notices of proposed deficiencies and had requested review by the Informal Conference Board ("ICB") were told by Department of Revenue officials that they had to withdraw their requests for ICB review, file amended returns reflecting the proposed assessment, pay under the Protest Monies Act, and proceed to court if they wanted to avoid double interest and penalties. Taxpayers that did so were met with motions to dismiss on the ground that such actions were not "ripe," since the taxpayers had not yet been issued notices of deficiency (just notices of proposed deficiency), and the allegation that, by filing the amended returns, they were "conceding" the asserted liabilities and the claim that the monies paid into the Protest Monies Act fund should be released to the Department of Revenue.⁴⁵

The U.S. Supreme Court has long held that due process requires states to offer taxpayers procedural safeguards against "unlawful exactions."⁴⁶ A state may discharge this constitutional obligation in one of three ways by offering: (1) a predeprivation remedy, where a taxpayer can challenge a tax prior to payment; (2) a postdeprivation remedy, where a taxpayer can pay the disputed tax and sue for a refund; or (3) some combination of the two.⁴⁷ Under Illinois amnesty provisions, taxpayers have been divested of meaningful predeprivation and postdeprivation remedies.

A state’s authority in devising and administering remedial schemes is not without limitations.⁴⁸ A fundamental limitation is that a state may not "reconfigure its scheme, unfairly, in mid-course—to ‘bait and switch.’"⁴⁹ By requiring taxpayers to either accept the Department of Revenue’s tax assertions or elect amnesty and forgo their opportunity to pursue their claims, bait and switch is precisely what the Illinois amnesty program did.

In Reich, the Court held that, under the Due Process Clause, a state may not offer "what plainly appears to be a ‘clear and certain’ postdeprivation remedy and then declare, only after the disputed taxes have been paid, that no such remedy exists."⁵⁰ The Court further explained that a state cannot deny a taxpayer relief on the ground that the state offered a predeprivation remedy when "no reasonable taxpayer" would believe that, in view of the apparent applicability of a postdeprivation alternative, the predeprivation remedy was the exclusive safeguard against illegal taxes.⁵¹ As in Reich, Illinois reconfigured a long-standing remedial scheme.

Illinois’ recent amnesty program left much to be desired – fairness and constitutionality – and set the stage for other offensive "amnesty" programs.

California recently ended two "amnesty" programs, one for corporate and personal income taxes administered by the Franchise Tax Board ("FTB") and another for sales and use taxes administered by the Board of Equalization ("BOE").⁵² These two programs, which ran from February 1, 2005 through March 31, 2005,⁵³ followed in Illinois’ footsteps, adopting many of the same punitive provisions. California’s programs, however, were not as generous as Illinois’ program inasmuch as only penalties for nonreporting or underreporting were forgiven.

Both of California’s amnesty programs were applicable to years beginning before January 1, 2003 and were available to taxpayers that had not been under criminal investigation, and whose liabilities were not the subject of pending court litigation and could not have qualified for amnesty under the State’s successful tax shelter "Voluntary" Compliance Initiative or the IRS’s Offshore "Voluntary" Compliance Initiative.⁵⁴ While taxpayers were permitted to file refund claims under the sales/use tax amnesty program, corporate and personal income taxpayers could not file refund claims for amounts paid under amnesty.⁵⁵

Like the Illinois program, California’s amnesty programs adopted a prophetic element. Penalties would apply to liabilities that taxpayers had no knowledge of at the time of the amnesty program.

The existence of the post-amnesty penalties and the requirement that taxpayers forgo their disputes and rights to refunds resulted in taxpayers opting to pay within the amnesty period but outside the amnesty program. This permitted taxpayers with challenges to preserve their right to dispute paid amounts without subjecting themselves to the hefty penalty should they not prevail. The FTB received almost $3 billion in payments from corporations, but it is estimated that the lion’s share of such payments was from corporations electing to avoid amnesty.

Taking a page from Illinois and California, North Carolina adopted a "Voluntary" Compliance Program, which was akin to the "tax shelter" reporting programs enacted by Illinois, California, Arizona, Connecticut, and New York, but had some of the offensive elements of the Illinois and California amnesty programs. The program, which was announced on December 28, 2004, was "in response to the North Carolina Court of Appeals’ unanimous decision in A&F Trademark, Inc. v. Tolson," a decision that was not (and is not, as of August 2005) final.⁵⁶ (A petition for certiorari has been filed in the United States Supreme Court). Entities participating in the program were required to pay all taxes and interest, without penalties, and were required to relinquish their refund rights.

In addition to the short time-frame provided to entities to consider the program, the Department of Revenue’s decision to offer the program during the pendency of A&F Trademark was particularly troubling. The issue in that case, i.e., whether income and franchise tax nexus exists without physical presence is, as mentioned above, probably the most contentious issue in state and local taxes today. It is an issue which will ultimately be resolved by Congress or the U.S. Supreme Court.

Given that penalties could total 60% of the tax due, entities were effectively bullied into relinquishing their due process rights. It is therefore not surprising that the "voluntary" program raised $255.6 million.⁵⁷

While amnesty programs may not be in the states’ best interests over the long haul, having decided to go the amnesty route, the states should get back on track. The new amnesty programs leave taxpayers scrambling to avoid their tentacles. States are divesting taxpayers (and purported taxpayers) of their right to challenge assessments without prepayment, by raising the interest and penalty stakes to newfound heights. This is contrary to the fundamental notion of amnesty and only serves to heighten controversies between states and taxpayers. It is anathema to fundamental rights of due process. You should not be penalized because you assert your legal rights. Losing your due process rights under the guise of an amnesty program makes the loss all the more offensive.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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